Regulate me

Ari Rubenstein

Published 2:49 PM ET Tue, 4 March 2014
CNBC.com

Earlier this month, the Securities Exchange Commission (SEC) released a draft of its 2014 Strategic Plan for public comment. The plan is technical, but the motivation is straightforward: increase investor confidence in our markets. This is a critical goal, and regulators and the industry alike must work together to achieve it.

It's hard to think of a sector that hasn't been improved dramatically by information technology, and Wall Street is no exception. Today, ultra-fast computers and advanced algorithms execute hundreds of transactions in fractions of a second. In 2005, high-frequency trading (HFT) accounted for 21 percent of trades in U.S. equities. In 2012, that figure had more than doubled to 51 percent.

"If Americans didn't trust that a digital dollar was as good as paper one, it would be hard to sell socks online, let alone stocks."

Long gone are the days when traders crowded exchange floors to make markets—and that's a very good thing for the average investor. Here's why:

The proliferation of HFT has democratized the marketplace in profound ways. Fierce competition between market participants means far better price discovery and stability. Automation has lowered the cost of executing and clearing trades, with broker commissions tumbling from upwards of $70 per trade in 1997 to less than a dollar today. The time it takes for critical information to reach investors has also decreased. And in a fully digitized marketplace—where every order, quote, and trade is electronically stored and easily audited—every thing is more transparent.

HFT has certainly led to better prices and a more level playing field. But the technical intricacy and speed of today's marketplace has undercut the public's trust. Infrequent but high-profile technology glitches grab headlines. And despite a wealth of evidence to the contrary, many wrongly assume that HFT caused the "flash crash" of 2010. The result is a general skepticism about—and growing distrust of­—the modern marketplace.

Trust is essential to widespread participation in any market. In fact, it's the basis of our currency itself, which is almost entirely virtual. If Americans didn't trust that a digital dollar was as good as paper one, it would be hard to sell socks online, let alone stocks. Over time, consumers have become comfortable with e-commerce, online banking, and mobile phone payments. It's time to create a similar level of comfort among investors in the modern stock market.

Jan Mammey | Stock 48 | Getty Images

It would be wonderful if our markets worked flawlessly without intervention, but that's just not the way it is. We need smart regulation to maintain stability and transparency, to weed out bad actors, and to instill investors with confidence.

That's where U.S. regulators come in, and they have a tough job to do. In order to enhance market quality, they've recently started a dialogue on new technical "pilot programs," including changing how exchanges charge customers to trade in their markets ("maker/taker pricing"), and the process by which brokers execute their customer orders in order to arrive at a best price ("trade-at"). Some industry participants would benefit from these pilots, and others would be adversely impacted. While I applaud regulation that seeks to enhance market quality, we should avoid adding layers of technical complexity through potentially risky experiments, and picking winners and losers in the process.

However, regulators have made other moves as of late that all of Wall Street can, and should, rally around. Last year, for instance, U.S. regulators proposed an important and enlightened regulation, Reg SCI, which would create standards and rules for the technology that drives HFT and other aspects of the modern marketplace. In October, the SEC also launched MIDAS, a public website that publishes trading data, which had been previously hard to access without expensive and sophisticated technology. Together, these efforts will bolster market stability, transparency, and investor confidence.

To be sure, regulation isn't cheap for the industry. In fact, better-regulated markets will make my business less profitable in the short-term. Safeguards can be extremely expensive to implement. New innovations must be adopted with extraordinary caution, so as to avoid costly and disruptive bugs. Incoming queries from regulators rightly demand significant attention, which distracts from business operations. But the price of a fair and efficient marketplace is well worth paying.

Wall Street will benefit not only from constructive regulation, but also from better educating investors about the technologies that underpin today's stock market. That's why I've teamed up with several competitors to create the Modern Markets Initiative, a new industry association launched last month, which will explain to the public what HFT is, how it works, and why today's equities markets are fairer and more efficient than ever before.

Innovation, more than anything, is at the heart of HFT. My firm's employees are PhDs, and more than a few are actual rocket scientists. Brilliant minds on Wall Street have produced extraordinary technologies that make our marketplace the best in the world. But going forward, the most critical innovation for our industry won't be new hardware or software—it will be a new spirit of collaboration with regulators, and a new emphasis on communication with investors.

—Ari Rubenstein is President and Chief Executive Officer of Global Trading Systems, a New York-based automated market maker and financial technology firm.

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